Investment Updates
Stay Focused On The Need For Tax-Aware Investing
Published Sunday, June 1, 2014 at: 7:00 AM EDT
You already know that it's the amount of money you keep, as opposed to the amount you earn, that matters in the end. Even more than any fees you may be required to pay, the biggest drag on investment earnings is usually taxes. And taxes may come in many forms, ranging from tax on ordinary income to capital gains tax to the 3.8% surtax on "net investment income" (NII)—and that doesn't include any state and local taxes.
To minimize the strain, reassess your portfolio so that it emphasizes "tax awareness." That could mean focusing on what investments you own as well as where you hold them, in tax-deferred or taxable accounts. For instance, it doesn't make sense to load up on tax-free municipal bonds in a tax-deferred IRA that essentially wastes munis' special status. But an IRA could be a good place to hold other bonds or dividend-paying stocks which generate annual income that might otherwise add to your tax bill.
If you wonder how much tax-aware investing can really help, take a look at the attached chart. For simplicity, we'll assume that someone invests $10,000 a year for 40 years and generates an 8% pre-tax rate of return. The final value shows a high of more than $2.5 million for a "boring" person who stays the course and effectively realizes a 0% tax rate as compared to a low of less than $1 million for an "exciting" trader who buys and sells assets frequently and ends up with a 50% tax rate. The numbers don't lie.
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